Sheila Berube has a head for numbers.
In the summer of 1971, she was traveling with her family in Ireland, which a year earlier had converted its punt to decimals. England had just done the same with its currency, making for a profusion of prices: the shillings and farthings of the old punts and pounds, and the pence of the new. Tourists and storekeepers alike were perplexed.
Not Sheila, then all of seven years old. “Shop clerks fumbled with conversion tables and calculators, but they didn’t know what was going on,” recalls her father, Robert Healy, a retired portfolio manager. “Yet Sheila could quickly give us all the prices in English, Irish and U.S. currency.”
Her native skill at mathematics serves Sheila Healy Berube, 41, well as head of 3M Co.'s $9.1 billion pension plan. But she has a strong command of more than just numbers. At a tumultuous time for U.S. pensions -- when many corporate plans are struggling to survive or, like IBM Corp., freezing in their tracks -- Berube in just four years has pushed the St. Paul, Minnesotabased company to the vanguard of pension investing.
She has led 3M into liability management, an approach to running a pension plan that few U.S. companies have tried; it involves a direct focus on plan obligations and a corresponding lengthening of plan maturities. Berube has also pushed 3M to invest in hedge funds for the first time in a decade, following a blowup of an earlier hedge fund investment; taken a sizable stake in commodities; introduced risk budgeting at the manager level; and applied portable alpha strategies to bonds -- virtually all pension executives use them only for stocks. Last, she’s given her managers room to run.
“Fresh thinking about old subjects pays off,” says the tall, redheaded Berube, who is the mother of six-year-old triplets. “Still, I don’t believe in change for change’s sake. Everything we do is carefully considered.”
“Sheila Berube is very smart,” says Rocaton Investment Advisors consultant Timothy Jackson, who has worked with 3M. “She’s open to new asset classes and methods of investing, and she has been extremely forward-thinking on integrating these programs into the portfolio.”
The performance of the plan, which covers 77,000 active and retired beneficiaries, attests to Berube’s savvy -- and to her faith in active management. At year-end the fund had 45 percent of its assets in U.S. equity; 17 percent in international stocks; 28 percent in fixed income; 9 percent in alternatives, mostly private equity; and 1 percent in cash. About 80 percent of 3M’s equity portfolio is actively managed.
Berube’s managers are coming off a superb year. In 2005 the plan returned 9.95 percent, compared with 4.9 percent for the Standard & Poor’s 500 index; 13.5 percent for the MSCI Europe, Australasia and Far East index; and 2.4 percent for the Lehman aggregate bond index. For the three years ended September 30, 2005, the plan returned an average annual 16.3 percent, versus a median 15.2 percent for large corporate plans. The year-end 2005 funding ratio for the 3M plan is estimated at a solid 95 percent.
Berube continues a long tradition of innovative investing at 3M. The company’s pension plan moved into international equities in 1982, about a decade before the sector became standard fare for U.S. institutions. The maker of Scotch Tape, Scotchgard and Post-It Notes also took its first stake in alternative assets in the late 1980s, buying distressed real estate. And 3M ventured into hedge funds in the early 1990s, when relatively few institutional investors could be found on the scene.
In early 2002, when Berube left her job as the endowment and pension overseer of a nonprofit hospital and joined 3M’s treasury division as finance manager -- a new title for the pension fund chief -- she quickly launched an asset-liability study. Completed in the summer of 2003, with help from consulting firm Watson Wyatt Worldwide, the study concluded that 3M’s plan should more explicitly manage assets to meet its liabilities.
That approach, far more common in Europe than it is in the U.S., is known as liability-driven investing (Institutional Investor, July 2005). And because liabilities are by definition long-term obligations, it proposes a focus on longer-duration securities, a more targeted pursuit of alpha and more extensive diversification.
“Instead of reaching for the highest risk-adjusted return on our $9 billion of assets, we’re going for a return relative to the liability,” Berube explains.
The best way to reach that return, she determined, was through a portable alpha strategy involving hedge funds. In the three years before Berube’s arrival, the 3M plan had been employing an off-the-shelf portable alpha approach in its stock portfolios, using enhanced equity index products from outside managers. To deliver more alpha and diversify the returns on the equity allocation, Berube proposed to the board that the plan move the strategy in-house; instead of enhanced index funds, she suggested using three funds of hedge funds to deliver the requisite alpha.
The trustees were leery. Back in 1990, 3M had invested in several hedge funds, including David Askin’s mortgage-bond-focused Granite Corp. The plan lost its entire $33 million stake in Askin’s fund -- 1 percent of its assets -- during the bond market rout of 1994, which sparked the collapse of the Askin fund. After that, 3M sold the rest of its hedge fund stakes -- a minimal amount -- and did not invest another penny in hedge funds until Berube arrived.
She persuaded the trustees that hedge funds came with manageable risks -- and potentially remarkable rewards. “The experience from the Askin deal certainly was a fear factor for the investment committee,” she recalls. “It was a long education process.”
Then, staking out fresh territory in pension investing, Berube embarked on a fixed-income portable alpha program. She used an interest rate swap, and hired six multistrategy hedge funds to deliver the excess return. As of year-end 2005, the program had added 450 basis points of pure alpha to the return on the swap, after just six months of operation.
GROWING UP IN MINNEAPOLIS WITH THREE OLDER and two younger sisters, Berube was the child most likely to follow in the footsteps of her father, who managed money for 33 years at IDS Financial Services, now Ameriprise Financial, a spin-off of American Express Co.
Berube graduated from Marquette University in 1985 with a degree in literature. Four years later she took a job as a stockbroker at Dain Bosworth, now RBC Dain Rauscher, in Minneapolis. She thought she would help clients plan their financial futures; instead, as she remembers it, “I hawked stocks to 50-year-old men who didn’t trust their wives with the checkbook.” Ready for a change, Berube moved to Japan, where she taught English as a second language for a year.
When she returned to Minneapolis in 1992, Berube decided to make a career in finance. She joined her father’s old firm -- he pulled no strings on her behalf -- starting in an entry-level job in operations. After two years she became an assistant to small-cap equity portfolio manager Gordon Fines. “She was outgoing, intelligent and willing to try new things,” Fines recalls.
In 1998, armed with an MBA from Minneapolis’s University of St. Thomas -- she had attended classes part-time -- Berube moved to the Minnesota State Board of Investment as a fixed-income manager.She jumped ship 18 months later to become director of cash and investments in the treasurer’s office at Allina Health System, a large not-for-profit hospital and clinic network based in Minneapolis.
She oversaw Allina’s $600 million in endowment funds and $200 million defined benefit plan. And she came to appreciate the power of hedge funds: The hospital had begun investing in a market-neutral fund of hedge funds in 1994.
“At Allina I learned that there is a lot of misunderstanding about hedge funds,” Berube says. “Seeing how well they worked gave me comfort with implementing hedge funds at 3M.”
Berube impressed her colleagues as an independent thinker and a capable manager. “Sheila is very low-key,” notes her former supervisor, Laurie Lafontaine, Allina’s vice president of finance and treasury. “She’s also very efficient. After the birth of her triplets, she never seemed stressed or out-of-whack.”
“After you have triplets, anything else is easy,” Berube says.
As Berube would be the first to point out, her efficiency is made possible in large part by her husband of 12 years. Brian Berube, 50, quit his job as an academic counselor at the University of Minnesota to stay home with the triplets. “He’s my secret weapon,” she says.
“Shortly after we got married, Sheila and I agreed that if we had children, it was important that one of us would stay home and raise them,” he says. “Sheila’s career was really taking off, so it was the logical decision.”
At 3M, Berube works closely with her boss, head of risk management Dennis Duerst, to recommend investment options to the plan’s trustees. “Sheila has a big-picture view and is incredibly consistent in her beliefs and ideas,” notes Duerst. “She doesn’t get too influenced by short-term events.”
Berube and Duerst make their presentations to the plan’s three trustees: 3M’s head of global benefits, Jan Angell; treasurer Janet Yeomans; and general counsel Richard Ziegler. The job of executing investment strategy and policy falls to Berube and her three-person staff.
When Berube arrived at 3M in early 2002, pension funds were still battling declining equity values and falling interest rates -- the so-called perfect storm that ran from 2000 through 2002. “Naturally, liabilities were front and center in my mind,” she says.
Her asset-liability study sparked a significant shift in perspective at 3M. “Both the asset-liability study and the risk budgeting showed that the tail can wag the dog, in that the liabilities can get away from you even if the assets are doing extremely well,” Berube says. “Benchmarks that look only at assets and markets make no sense if your fund is losing ground. You want to stay ahead of your liabilities.”
Other pension executives and consultants are less enthusiastic about liability-driven investing. They point out that pension funds, as long-term investors, can afford to, and should, take on the short-term risks of stocks because they pay a premium vis-à-vis bonds. That premium will help to guarantee that plan obligations can ultimately be met.
Berube views the plan’s liability not as a fixed obligation that is recalibrated each year but as a dynamic liability -- the mirror image of a bond inasmuch as it decreases the value of the plan’s net assets when interest rates fall and increases the value when interest rates rise.
The need for more long-duration assets led Berube to conclude that it “made no sense” to use an active duration manager that has the option to hold cash or long-duration bonds. Berube dismissed the plan’s active duration manager, Austin, Texasbased Hoisington Investment Management Co., despite solid long-term performance, and put in place a long-duration interest rate swap. It’s matched to the plan’s liabilities and ties up no cash. The duration of the liabilities of the 3M plan is 13 years. The range for pension liability duration: 12 to 16 years.
“On that part of the portfolio,” Berube says, “the swap eliminated duration risk and freed up $500 million for a second portable alpha program.”
Although 3M had been deploying a portable alpha strategy since 1999, it used a simple approach that relied on enhanced index funds to deliver alpha. In February 2003, Berube began a new portable alpha program, using hedge funds, which 3M applied to its stock portfolio. Berube allocated $100 million to each of three fund-of-hedge-fund managers: New Yorkbased Blackstone Alternative Asset Management; Rock Creek Group, of Washington, D.C.; and Stamford, Connecticutbased UBS O’Connor.
“The funds of hedge funds are low risk and low return, and provide a nice, uncorrelated alpha,” Berube says. From inception the strategy has delivered between 100 and 500 basis points a year over the S&P 500, net of fees -- a terrific performance.
Bolstered by the success of her hedge fund strategy, Berube made a case for a new kind of portable alpha, one in which alpha would for the first time be deployed on the plan’s bond portfolio. It was a provocative notion. Even today relatively few pension plans use portable alpha on their fixed-income portfolios.
“Applying portable alpha to fixed income is a much more complicated decision, and the implementation is trickier than it is for equities,” says Rocaton consultant Jackson, who helped design 3M’s program. With equities, there are only two benchmarks a sponsor might want to use as an overlay -- the S&P 500 and the Russell 1000 -- and both are inexpensive. In fixed income, the consultant says, “there are a greater number of choices for the underlying beta, and it’s difficult and expensive to find the exposure.” In addition, the portable alpha program extends the duration of the plan’s assets. That means greater volatility on the asset side from the longer bonds, which are meant to match the wide swings in the value of the long-lived liabilities.
“Most pension funds see that it makes sense to use portable alpha with large-cap U.S. equities,” Jackson says. “Sheila Berube is one of the few pension executives who realizes that adding alpha to a U.S. fixed-income index can knock the ball out of the park.”
Not surprisingly, though, the 3M plan trustees were wary of staking out such new ground.
“The trustees felt they just didn’t know enough about how this would work,” Berube recalls. The board asked the new pension chief to make many presentations to individual trustees as well as to the assembled board. After two and a half years, Berube won the board over. “We eventually met twice with [then-CEO] James McNerney,” she says. “He wasn’t on the committee, but the trustees weren’t comfortable until we had gone all the way to the top.”
The board trusts Berube’s judgment in assessing the army of hedge fund candidates. In her evaluation process she focuses intently on volatility. “There are great funds that return 10 percent over LIBOR with 12 percent volatility, but we’d rather have 500 basis points over LIBOR with low volatility,” Berube says.
She doesn’t get starstruck. Recently, Berube had a series of meetings with a high-profile New Yorkbased quantitative hedge fund manager she was considering to provide portable alpha. Despite the firm’s strong track record and its “aura of brilliance,” as she puts it, she decided against hiring the manager. “I asked them the same questions in different ways and got consistent answers, but I consistently couldn’t understand them,” she notes.
Like a growing number of her peers, Berube invests in commodities. “We like the diversification that commodities offer and the fact that they have a very low correlation to equity and bond markets.” In April 2004, 3M invested $200 million in a structured product offered by American International Group. The stake was valued at $260 million at year-end 2005.
Berube has expanded 3M’s risk budgeting process, which used to merely analyze the plan at the asset-class level, to take account of the results of individual managers and the interaction of their strategies’ betas and alphas. “You can be slightly wrong on your future return expectations or your correlation between managers, and it can totally change the return of the plan,” she says.
Good leaders allow others to do their jobs, and Berube certainly applies that principle in dealing with her money managers. In February 2005, for example, 3M assigned a $450 million global equity mandate to Boston-based Acadian Asset Management. Acadian’s strategy chooses among securities within the U.S., the developed international markets and emerging markets, and can tactically vary the allocation of assets among markets. Database provider EVestment Alliance reports that Acadian’s global strategy has beaten an MSCI global index by a staggering average of 1,000 basis points annually for the past five years.
The pension chief is now developing a “second dimension” asset allocation framework that will group assets and managers according to their historical and expected total risk and return rather than by their equity or fixed-income investing styles. “It’s important to get out of the consultants’ boxes,” she says. “Portable alpha creates risk and return, but it’s not in any traditional asset class. It’s time to think less about what investments are called and more about the risk and return they create.”
Such fresh thinking is rare in the pension field -- it’s rare in any field -- but as Sheila Berube proves, it’s far from extinct.
Tale of the tape
Sheila Berube has injected a hefty dose of portable alpha into the 3M Co. pension plan, but the fund’s traditional money managers deliver their share of the sweet stuff too. Last year the 3M pension plan returned 9.95 percent, far surpassing the 4.9 percent for the Standard & Poor’s 500 index and the 2.4 percent return for the Lehman Brothers aggregate bond index.
Thanks to a timely bias toward value over growth, 3M’s U.S. equity portfolio, representing 45 percent of plan assets, returned 8.2 percent in 2005. Over three years it returned an average annual 15.9 percent, compared with 14.4 percent for the S&P 500; over five years -- Berube joined 3M four years ago -- it returned an annualized 2.0 percent, versus 0.5 percent for the index. The plan’s two major U.S. stock pickers are AllianceBernstein Capital Management, which runs a large-cap growth strategy for 3M, and longtime value manager Boston Partners Asset Management, which has beaten its benchmark since it opened its doors in 1995.
Meanwhile, 3M’s international stock portfolio, representing 17 percent of plan assets and split evenly between all-cap value and growth styles, has slightly underperformed, returning 12.3 percent in 2005, versus 13.5 percent for the MSCI Europe, Australasia and Far East index. But the managers, led by GMO, which has handled 3M’s money for 23 years, outperformed over the past three years, posting an annualized 24 percent return, compared with 23.7 percent for the MSCI EAFE index. Over five years the group returned an annualized 8.9 percent, versus 4.6 percent for the index.
But 3M’s stock pickers take a backseat to the plan’s bond brigade. Beating their benchmarks by an especially wide margin, the fixed-income managers, led by Pacific Investment Management Co., returned 9.4 percent in 2005, compared with 2.4 percent for the Lehman aggregate index. That outperformance reflects 3M’s smart bet on long-duration securities. The plan’s bond portfolio returned an annualized 10.6 percent for three years, versus 3.6 percent for the Lehman index, and 10.4 percent for five years, versus 5.9 percent for the benchmark. -- J.K.
